Thursday, August 25, 2011

Benefits of Diversification

In 1971, the US dollar was removed from the gold standard for good. Since then, the price of gold has risen, though basically in spurts. The equity market has also been subject to major cycles. Looking at the raw price of gold and comparing this to the total US equity market return, you see both end up around the same place: 7.9% for Equities, 7.0% for gold, through 2010. But combined 50-50, and reweighting each year, one would generate an 8.4% return via the lower volatility (geometric average is greater due to its lower volatility).

6 comments:

Some would refer to this as asset allocation rather than diversification, but the "Permanent Portfolio" concept is based on similar reasoning, though versions of it often include Treasury Bonds and cash in addition to stocks and gold.

Gold's "yield" from the term structure of futures contracts has been (on average and in total since the contracts originated) NEGATIVE. So using the phrase "forgoing the yield" is not, technically, correct.

Okay I understand your point about diversification, but do you really believe in the long-term intrinsic value of gold? Won't I get even better Sharpe then if I put equal shares of my wealth into stocks, bonds, gold, treasuries, real estate, antique cars, and Beanie Babies?